SPA (Share Purchase Agreement)
If an agreement is reached after the due diligence, an SPA or share purchase agreement will follow. This is a basically binding final agreement on the object and price, in which all matters necessary in a takeover are included. These include the negotiated declarations and warranties, the price mechanism, when the risk is transferred, etc. In short, it is the agreement with the object of buying and selling the shares of a target company.
After identifying the parties, a takeover agreement often includes a preamble. This is an introductory text that outlines the background, motives and intentions of the parties. Later, in a possible arbitration, the arbitrator will be able to use this document as a handle to get more information on the background of the agreement. Such a preamble has no further binding force, but does have an important interpretative meaning.
In each SPA, you will find a number of standard clauses, the socalled “four corners clauses”. These deal with the completeness of the contractual arrangements made, the applicable law, jurisdiction and rules of interpretation.
Completeness of the contractual arrangements made: among other things, contractual arrangements will be made about which rules will still apply now that the parties have reached a final agreement. In particular, the previous agreements on confidentiality will have to be laid down by contract.
Applicable law: As regards the applicable law, Anglo-Saxon countries will often want to put forward their own M&A practice. Perfectly possible and again a matter of negotiation.
Jurisdiction: very often disputes about M&A agreements will be settled by arbitration. In that case, this must be explicitly included in the agreement and it will also have to be clear from the agreement what kind of arbitration the parties want.
Rules of interpretation: the Civil Code contains a whole series of rules of interpretation. Do they apply? To what extent do they apply? Am I going to extend them, define them, detail them?
An M&A deal is actually no more or no less than a negotiation game where the essence of the negotiation is about the question: “who bears what risk? The buyer will try to hedge against problems in the underlying business by having the seller
make a number of statements, also known as representations. Such a representation is actually a statement that is immediately secured. This means that if the statement does not correspond to reality, the seller has breached his guarantee, with the result that the seller must pay the buyer compensation for the loss. This is an invention of the practice of accommodating common law defects. Thus, the buyer will impose a list of statements on the seller based on (or lack of) information from the due diligence report. Such declarations usually concern a number of standard issues characterising the quality of the various components of a company, such as: the tax situation, the staff, environmental aspects, disputes, contracts, annual accounts, etc.
Whether a seller wants to guarantee such statements remains to be seen. Each transaction has its own specificity and, depending on the negotiating position, the seller will give more or less guarantees. It could be that when a seller identifies all possible risks and communicates them to the buyer, the seller will want to place the risk entirely on the buyer from that moment onwards. On the other hand, the buyer may be reluctant to accept the seller’s honesty in identifying the risk. Therefore, a balance will have to be found between buyer and seller as regards to the risk allocation and the related pricing. It will be a matter of negotiation.
Naturally, a seller will want to keep the duration of these representations and warranties as short as possible. In practice, this is strongly negotiated because the buyer wants to keep the seller’s liability as long as possible. Depending on the nature of the declarations and warranties, a term will be set. In practice, it is recommended to provide for a minimum period of eighteen months so that a complete financial year is behind them, the annual accounts have been prepared and an audit has taken place. If there are visible risks, these will normally be discovered within these eighteen months. As a buyer, one naturally wants to let the limitation period run as long as possible. The longest one encounters in practice is a limitation period of seven years. This is very specific for tax infringements as the tax authorities can go back seven years during a tax inspection.
As a seller, you want to limit your liability not only in time but also in scope. In practice, there are three contractual ways of doing this, which are often combined:
1. De minimis. This means that a breach of the representations and warranties must represent a certain monetary value.
Only when the breach exceeds a certain amount, the buyer will sue the seller.
2. The basket. A basket in which all claims are deposited and one can only claim damages when the basket is full. Two possible systems can be distinguished here: a franchise and a threshold. With a franchise, there must be, for example, 10,000 euros worth of claims in the basket. If the 10,000 Euros is a franchise, the buyer will only be paid for an amount exceeding the 10,000 Euros (the same as the franchise known from insurance law). If the 10,000 euros is a threshold, then when the basket is full, the buyer will be paid from the first euro.
3. The cap. A third possibility to limit the extent of the seller’s liability is to set a cap to which a seller can be bound. In practice, this can go in any direction and this clause is most often negotiated in takeover contracts. In many cases, the maximum liability of the seller will be limited to the amount of the sale price.
Also a matter of negotiation are the specific indemnities. For example, a risk was discovered during the due diligence but
neither party knows whether this risk will manifest itself in the future. For example, in the target five years ago, figures were tampered with, which may have resulted in tax fraud. Then you, as the acquirer of the shares, will run the risk that the company will be fined by the tax authorities for this, since they can go back seven years in time. It could also be that the tax authorities never discover the fraud but you are exposed to a great risk. In that case, it is not inconceivable that a buyer would want to have a specific indemnification recorded for this.
He could ask the seller to deduct this potential damage from the purchase price. If, as a purchaser, you are not confident that the seller will pay compensation if the risk materialises, you can always rely on a bank guarantee. If the risk materialises, the bank, on behalf of the seller, will pay the damages due. Another solution is not to pay the whole purchase price to the seller but to place part of it in the custody of a third party (often a notary). Also known as an escrow.
The moment the buyer discovers a breach of the representations and warranties and/or of the specific indemnities, the buyer will notify the seller via a claim notice. This will include provisions clarifying how the seller can defend himself against the buyer’s
claim and within what time frame. If no agreement is reached, the matter will be settled through the courts or arbitration, depending on what was agreed by the parties.
The question therefore is when the risk of the company is best transferred. Parties will preferably choose the date of the closed, approved and audited financial statements of the target company. Since this rarely works out in practice, they will look for figures that are as close as possible to the moment when the risk is transferred. That is why interim figures are often used. In that case, price adjustment mechanisms will be provided whereby a provisional agreement will be reached on a specific date on the basis of figures known at that time. If, at the time of the closing and therefore the moment at which the buyer actually starts to bear the risk, there is a large difference between the provisional figures on which the parties are based and the final figures as they appear, then the price will be corrected (both in plus and in minus).